Ocado's problem – not enough jam today

This week all eyes will be on two retail announcements - one by a new boy and
one by a somewhat older boy. Ocado, the online retailer that floated earlier
this year raising £200m, will announce its third-quarter results. Morrisons,
the once North of England-biased supermarket chain that has no significant
online presence, will announce its half-year results.

By Kamal Ahmed

6:47PM BST 04 Sep 2010

There will be two very different stories. Morrisons' new CEO, Dalton Philips, will have plenty of fresh jam to offer shareholders. Analysts expect profits before tax to be around the £400m mark, up as much as 15pc year on year. Retail and fuel sales will be on an improving curve and earnings before interest, tax, depreciation and amortization (Ebitda) are likely to increase 13pc with an interim dividend forecast at 1.24p, also up 15pc. Those at the bullish end of the market believe Morrisons is a strong buy.

Although it is Mr Dalton's first major outing since becoming chief executive six months ago after Marc Bolland's departure to Marks & Spencer, don't expect any sharp divergence in strategy. As an analyst note from RBS says, Sir Ian Gibson, Morrisons' chairman, has made it clear that in the long term, the retailer will consider opportunities for online retail, international expansion and non-food product lines. At the moment all the focus is, almost literally, on the meat-and-potatoes end of the business.

In these economically worrying times, doing fancy stuff isn't quite the order of the day.

Contrast this with Ocado, the rather racier new kid on the block, which has nervous investors wondering whether it will ever get a business model as positively received as its customer proposition. Ocado and its leadership of eye-wateringly positive ex-Goldman bankers are relying on a "jam tomorrow" rather than "jam today" story. In fact, with profits not forecast until 2011/2012 – and only then if the retailer achieves pretty punchy growth figures – it's not so much jam today as a rather thin sliver of margarine today and promises of full-fruit Bonne Maman at some point in the indistinct future.

Ocado's leadership of Jason Gissing, Tim Steiner and Andrew Bracey will need to construct a compelling narrative on expansion and earnings if they are to head-off the doubters and see a more robust trajectory for their shares, which at one point traded as low as 131p. At the market's close on Friday, the share price had picked up to 157p e_SEnD still nearly 13pc below its IPO price of 180p. In a somewhat disobliging analysis last week, Morgan Stanley, one of the few institutions it seems Ocado didn't hire to advise on its float, said the share price could fall as low as 80p.

This seems overly pessimistic. Ocado is in a growth market – online retail is set to grow at 15pc a year for the next five years – and its operating model is unique and well tested. The retailer also has plenty of opportunities to expand its geographical footprint through the addition of a new distribution centre in the Midlands. At some point, its unique and market-leading distribution system could be bought by a foreign retailer for use overseas.

Yes, there are significant headwinds. Morrisons will produce an online offer at some point and M&S is similarly thought to be considering strengthening its online presence in food. Ocado's exclusive link with Waitrose is both a help (a loyal and expanding customer base) and a hindrance (a limit on the range of products that Ocado can offer and a partnership with a retailer that, within the M25 at least, is also a competitor via Waitrose Direct).

But, as long as it is able to show strong market and revenue growth in the figures this week, Ocado is still a worthwhile bet for success. As UBS said in a note last week, the retailer is likely to enter the FTSE 250 at the next review this month and this will increase buying demand as index funds build positions. Ocado's currently limited register means that the share price is volatile and under-valued.

Jam tomorrow is always, quite rightly, a difficult message to pull off for investors who have heard it all before. Ocado has some big investments to make, not least in its new distribution centre. But in this case, as long as the growth figures are as expected, jam tomorrow might be exactly what we get.